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Outlook on Global Equity Income Summary • The selloff in bonds during the quarter drove a rotation away from cyclical value stocks back to defensives and companies perceived to offer secular growth, reversing the trend that took place in 2016. • The direction of travel in global monetary policy is clear, as the debate now revolves around the timing and pace of rate hikes and balance sheet normalization. • While valuation focused strategies have struggled during this period of artificially low rates, we feel they are well positioned for a new environment of more traditional monetary policy. JUL 2017 Global equity markets continued to rally during the second quarter even as inflation expectations and interest rates fell and US economic data disappointed. The decline in rates drove a rotation away from cyclical value stocks back to defensives and companies perceived to offer secular growth, reversing the trend that took place in 2016. Global equities generated midsingle digit returns in local currency terms during the second quarter although the steady index level returns masked significant divergence among individual sectors. Technology significantly outperformed, particularly social media companies and other technology stocks perceived to offer secular growth, as did healthcare, which rebounded as concerns over tighter US regulation of drug prices abated. In contrast, commodity sectors, such as materials and particularly energy, significantly underperformed. More defensive sectors were mixed as consumer staples and utilities performed in line with the broad market while telecoms significantly lagged, which was surprising since the group typically does well amid declining rates. European stocks benefited from political risk abating following the French election while stocks in Asia performed well, driven by China. The US market lagged modestly, despite strength in technology growth stocks, while returns in Latin America were weighed down by increased political uncertainty in Brazil. While the decline in oil prices and weakness in US economic data this year have understandably led investors to question the potential for normalization in inflationary pressures, we do not believe the global economic outlook has changed dramatically since the beginning of the year. While there has been some pullback in indicators of expected global growth and inflation this year, the environment remains one characterized by a slowly improving global economy with central banks around the world moving toward reducing monetary stimulus. Much of the decline in inflation expectations has been due to oil prices falling and no longer being meaningfully higher on a year-on-year basis. The oil price weakness has been a function of elevated supply as US shale production has been resilient while demand, a better indicator of the economic outlook, continues to be above expectations. In addition, broader measures of commodity prices remain near levels seen at the beginning of the year and global trade continues to recover. Credit spreads globally remain very low, lacking signs of market stress seen early in 2016 when oil prices fell sharply. Corporate earnings have been strong and estimates of future earnings are being uncharacteristically revised higher, particularly among more cyclical companies. In addition, surveys of business and consumer confidence remain robust and labor markets around the world are improving. The relative performance of value strategies has been highly sensitive to bond yields and inflation expectations in recent years so it is not surprising that value has struggled so far in 2017. However, the underperformance of value has overshot what would have been expected from the move in interest rates as rates remain well above their levels from a year ago while value has given back all of its outperformance in the second half of 2016. US growth has clearly slowed during the past 18 months but the remainder of the developed world has accelerated leading to much more consistent growth rates around the world. This has weighed on the US dollar, which had been supported by inflows seeking more attractive investment opportunities in a faster growing economy. However we feel this synchronized pattern of global growth is more sustainable and less likely to be derailed by an economic shock emanating from a particular country. This contrasts with the environment in recent years when nearly all global growth was driven by the US and China. Europe appears to finally be truly recovering after languishing since the global financial crisis as first quarter growth exceeded expectations and leading indicators of growth are at high levels. Private sector credit growth has turned positive after declining during the sovereign debt crisis, leading to a rebound in capital spending. In emerging markets, major countries such as Brazil and Russia are expected to rebound from recessions while China continues to grow at a very robust rate. RD22125 Outlook on Global Equity Income The US remains a broadly expensive market with income stocks within the US trading at an uncharacteristic valuation premium. In addition, US growth rates are no longer above that of other developed regions while political uncertainty in the US has also clearly increased. In contrast, the political environment in Europe has improved. The uncertainty created by the UK Brexit vote and the election of Donald Trump seems to have slowed the move toward populism in Europe, with centrists winning elections in France and the Netherlands and populists losing support in Italy. In addition, valuations are much more attractive in Europe relative to the US, and we believe European companies have a much higher likelihood of a cyclical improvement in earnings given that they remain depressed versus history—unlike US earnings, which have already rebounded to new highs. Emerging markets continue to offer the most attractive valuations globally. Emerging markets have now outperformed for over a year as fears of a Chinese hard landing have abated and commodity prices have stabilized. An environment of US dollar weakness and stable commodity prices is also supportive of emerging markets equities, and we believe the inclusion of China’s domestic “A” shares in MSCI indices is likely to improve sentiment further. In addition, investors have begun to appreciate that in a world starved of robust GDP growth, companies operating in environments with structurally faster growth are attractive. The strategy’s sector allocation detracted from performance in 2017 as energy, a sizable weight in the strategy, lagged materially. In addition, within defensive sectors the strategy had a heavy exposure to telecoms since valuations remain in line with historical norms and as their domestic orientation provide insulation from potential increased protectionism. Exposure to consumer staples and utilities was much lower as valuations in these groups are well above historic norms. This positioning was detrimental as staples and utilities significantly outperformed telecoms. Sector deviations versus the benchmark have been reduced modestly to ensure stock selection is the key driver of relative performance, although the strategy remains skewed away from sectors trading at substantial premium to their historical valuation ranges. While markets may gyrate on every comment from a major central banker, the direction of travel in global monetary policy is clear as the debate now revolves around the timing and pace of rate hikes and balance sheet normalization. Ultra-low interest rates and quantitative easing have distorted the valuations of a variety of assets, boosting the price of defensive, bond-like equities while depressing the valuation of cyclicals and businesses where the medium-term outlook for profitability is difficult to predict. As nontraditional monetary policy comes to an end, we would expect the relative valuations of different parts of the global equity market to return to historical norms. Valuation focused strategies have struggled during this period of artificially low rates but the market rotation during the second half of 2016 showed how violently markets can shift on any sign that the current sluggish, low rate environment could end. Valuation focused strategies have generated substantial value in the equity market over the long term and we feel they are well positioned for a new environment of more traditional monetary policy. This content represents the views of the author(s), and its conclusions may vary from those held elsewhere within Lazard Asset Management. Lazard is committed to giving our investment professionals the autonomy to develop their own investment views, which are informed by a robust exchange of ideas throughout the firm. Important Information Published on 11 July 2017. Information and opinions presented have been obtained or derived from sources believed by Lazard to be reliable. Lazard makes no representation as to their accuracy or completeness. All opinions expressed herein are as of the published date and are subject to change. Certain information included herein is derived by Lazard in part from an MSCI index or indices (the “Index Data”). However, MSCI has not reviewed this product or report, and does not endorse or express any opinion regarding this product or report or any analysis or other information contained herein or the author or source of any such information or analysis. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any Index Data or data derived there from. The MSCI Index Data may not be further redistributed or used as a basis for other indices or any securities or financial products. High yielding securities may carry a greater risk of capital values falling or of limited prospects of capital growth or recovery. No investor should invest in high yield securities unless he or she is prepared to accept a high degree of risk to both capital and income. Investments in emerging markets carry an above-average degree of risk due to the undeveloped nature of securities markets in the emerging countries. Investors should consider whether or not investment in such a strategy is either suitable or should constitute a substantial part of their portfolio. This material is provided by Lazard Asset Management LLC or its affiliates (“Lazard”). There is no guarantee that any projection, forecast, or opinion in this material will be realized. Past performance does not guarantee future results. This document is for informational purposes only and does not constitute an investment agreement or investment advice. References to specific strategies or securities are provided solely in the context of this document and are not to be considered recommendations by Lazard. Investments in securities and derivatives involve risk, will fluctuate in price, and may result in losses. Certain securities and derivatives in Lazard’s investment strategies, and alternative strategies in particular, can include high degrees of risk and volatility, when compared to other securities or strategies. Similarly, certain securities in Lazard’s investment portfolios may trade in less liquid or efficient markets, which can affect investment performance. Australia: FOR WHOLESALE INVESTORS ONLY. Issued by Lazard Asset Management Pacific Co., ABN 13 064 523 619, AFS License 238432, Level 39 Gateway, 1 Macquarie Place, Sydney NSW 2000. Dubai: Issued and approved by Lazard Gulf Limited, Gate Village 1, Level 2, Dubai International Financial Centre, PO Box 506644, Dubai, United Arab Emirates. Registered in Dubai International Financial Centre 0467. Authorised and regulated by the Dubai Financial Services Authority to deal with Professional Clients only. Germany: Issued by Lazard Asset Management (Deutschland) GmbH, Neue Mainzer Strasse 75, D-60311 Frankfurt am Main. Hong Kong: Issued by Lazard Asset Management (Hong Kong) Limited (AQZ743), Unit 7, Level 20, One International Finance Centre, 1 Harbour View Street, Central, Hong Kong. Lazard Asset Management (Hong Kong) Limited is a corporation licensed by the Hong Kong Securities and Futures Commission to conduct Type 1 (dealing in securities) and Type 4 (advising on securities) regulated activities. This document is only for “professional investors” as defined under the Hong Kong Securities and Futures Ordinance (Cap. 571 of the Laws of Hong Kong) and its subsidiary legislation and may not be distributed or otherwise made available to any other person. Japan: Issued by Lazard Japan Asset Management K.K., ATT Annex 7th Floor, 2-11-7 Akasaka, Minato-ku, Tokyo 107-0052. Korea: Issued by Lazard Korea Asset Management Co. Ltd., 10F Seoul Finance Center, 136 Sejong-daero, Jung-gu, Seoul, 04520. People’s Republic of China: Issued by Lazard Asset Management. Lazard Asset Management does not carry out business in the P.R.C. and is not a licensed investment adviser with the China Securities Regulatory Commission or the China Banking Regulatory Commission. This document is for reference only and for intended recipients only. The information in this document does not constitute any specific investment advice on China capital markets or an offer of securities or investment, tax, legal, or other advice or recommendation or, an offer to sell or an invitation to apply for any product or service of Lazard Asset Management. Singapore: Issued by Lazard Asset Management (Singapore) Pte. Ltd., 1 Raffles Place, #15-02 One Raffles Place Tower 1, Singapore 048616. Company Registration Number 201135005W. This document is for “institutional investors” or “accredited investors” as defined under the Securities and Futures Act, Chapter 289 of Singapore and may not be distributed to any other person. United Kingdom: FOR PROFESSIONAL INVESTORS ONLY. Issued by Lazard Asset Management Ltd., 50 Stratton Street, London W1J 8LL. Registered in England Number 525667. Authorised and regulated by the Financial Conduct Authority (FCA). United States: Issued by Lazard Asset Management LLC, 30 Rockefeller Plaza, New York, NY 10112.